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Japanese Accounting Gets Rare Ray of Sunlight: Jonathan Weil

By Jonathan Weil
March 01, 2012

The auditing profession’s top U.S.
overseer usually does a flawless job of safeguarding the most
embarrassing secrets of accounting firms and their corporate
clients. Fortunately, every now and then, the watchdog slips up.

Take the case of Kyoto Audit Corp., a Japanese affiliate of
the Big Four auditor PricewaterhouseCoopers. On Feb. 14, the
U.S. Public Company Accounting Oversight Board released its
first-ever inspection report on the Kyoto-based firm.

The report said the board’s staff reviewed the firm’s
audits for two companies and found serious problems with both.
The deficiencies were so severe, it appeared that “the firm at
the time it issued its audit report had not obtained sufficient
competent evidential matter to support its opinion on the
issuer’s financial statements,” the report said. In other
words, the companies’ books could have been horribly wrong, and
the auditors wouldn’t have known it.

Who were these two companies? The report didn’t say, in
keeping with the board’s longtime policy of refusing to name the
companies where its inspectors find botched audits. In this rare
instance, though, it wasn’t hard to figure out their identities.

That’s because Kyoto Audit has only two audit clients with
U.S.-registered securities. One is Kyocera Corp., a maker of
mobile phones and electronic equipment, which has a stock-market
value of $17.2 billion. The other is Nidec Corp., the world’s
biggest maker of motors for hard-disk drives, which has a $13.6
billion market value. So there, the cat’s out of the bag.
Undoubtedly, the companies and the auditor would have preferred
you not know.

Lousy Job

After last year’s accounting-fraud scandal at Olympus
Corp. (7733), the medical-equipment company whose books had been
blessed by the Japanese arms of Ernst & Young and KPMG, few
things would be more important to an investor in a Japanese
manufacturer than the knowledge that its auditor did a lousy
job. If investors can’t trust the audit, they might not be able
to trust the numbers.

This is the fourth column I’ve written revealing the names
of publicly held companies whose external audits were criticized
in the board’s inspection reports. Hopefully someday the board
will change its policy, considering its stated mission is “to
protect the interests of investors.”

Historically, the board has said it’s prohibited from
naming audit firms’ clients by the Sarbanes-Oxley Act, which
created the regulator in 2002. As I’ve pointed out in previous
columns, the plain language of the law undercuts this assertion.

The act says the public portions of inspection reports
“shall be made available in appropriate detail,” subject to
“the protection of such confidential and proprietary
information as the board may determine to be appropriate.” Put
another way, it’s the board’s call whether to disclose
companies’ names, although the Securities and Exchange
Commission, which oversees the board, could overrule it. The
obvious beneficiaries of the secrecy policy are the accounting
firms and their audit clients.

The board’s inspectors conducted their review at Kyoto
Audit in December 2010 and January 2011. The deficiencies they
found included “the failure, in both audits, to perform
adequate substantive analytical audit procedures to test
revenue.” Revenue, of course, is the most important line on the
income statement.

The report also cited Kyoto Audit’s failures to perform
sufficient procedures “to test the allowance for doubtful
accounts” and “to test inventory valuation.” The report
didn’t provide further details. In plain English, this means the
firm hadn’t done enough to check whether sales figures were
accurate, customers could pay their bills, or unsold products
were worth what the books said. Kyocera (KYO) and Nidec are both based
in Kyoto.

No Changes

Kyoto Audit’s managing partner, Yukihiro Matsunaga,
declined to discuss the firm’s work for the companies. In an
Oct. 24 letter to the board, Kyoto Audit said it performed
additional audit procedures in response to the inspectors’
findings. “The completion of those procedures did not result in
changes to our audit reports or to the issuers’ financial
statements,” the firm said. Lucky them.

A spokeswoman for the accounting board, Colleen Brennan,
declined to comment. So did a Nidec spokesman, Masahiro
Nagayasu.

A Kyocera spokesman, Judah Reynolds, said the company is
“confident in the quality” of Kyoto Audit’s work and that the
information in Kyocera’s financial reports “is of high quality
and complies with all relevant requirements.” He declined to
comment on the inspection report.

Founded in 2007, Kyoto Audit has a colorful history. In
2006, Pricewaterhouse’s Japanese affiliate, Chuo Aoyama, was
ordered by Japan’s Financial Services Agency to suspend
operations for two months after the regulator found the audit
firm had helped Kanebo Ltd., a Japanese cosmetics company,
falsify its financial reports. Three Chuo Aoyama auditors
pleaded guilty to criminal charges.

Chuo Aoyama later changed its name to Misuzu. After more
accounting scandals surfaced at its clients, the firm shut down
in 2007. The audit teams at Misuzu that had been covering
Kyocera and Nidec (NJ) moved to the newly formed Kyoto Audit. The two
companies switched audit firms that year along with them.

Today, Pricewaterhouse classifies Kyoto Audit as a
“cooperating firm.” It’s not a full-fledged member of the Big
Four auditor’s global network. However, it has the right to use
Pricewaterhouse’s audit methodology, and has access to the
“expertise of the PwC network,” according to Kyoto Audit’s
filings with the accounting board. A Pricewaterhouse spokesman,
Mike Davies, declined to comment on the inspection report.

Affiliations aside, what matters most to investors about
this or any other accounting firm is whether it has blown the
audit of a company in which they hold a stake. There’s only one
way the accounting board will ever shed its image as a protector
of the industry it’s supposed to be regulating: Start naming
names. The public needs to know.

(Jonathan Weil is a Bloomberg View columnist. The opinions
expressed are his own.)

To contact the writer of this article:
Jonathan Weil in New York at
jweil6@bloomberg.net.

To contact the editor responsible for this article:
Mark Whitehouse at mwhitehouse1@bloomberg.net